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If, as it is said, markets move due to either greed or fear, there is little doubt which emotion ruled in 2008. A pervasive fear cast a shadow over every aspect of dealmaking, chilling activity across Europe. Most deals were defensive, reacting to the widespread anxiety, if not outright panic, that gripped analysts, investors and bankers throughout the year.

Take Noreco, a Norwegian oil and gas company. In September it was forced to address rumours that it was close to breaching a covenant on a NKr2.8 billion (€310m) bond it issued a year earlier. “We felt that the market was too focused on a covenant and not what the company delivered,” says Jan Nagell, Noreco’s CFO.

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As the company’s share price fell in concert with oil prices, the headroom under the covenant, based on a ratio of market value of equity to debt, deteriorated. Though Nagell says that the company was never in serious risk of a breach, it sensed a growing danger from opportunistic traders “making a play” on the rumours, attacking Noreco’s shares in the hope of bringing about a breach. In order to “put the right focus on the company,” in October the CFO offered to buy back 20% of the outstanding bonds at par — they were not due to mature for a year and a half — in return for removal of the high-profile covenant.

Noreco is far from alone in being forced to defend its balance sheet in recent months. According to Standard & Poor’s, covenant breaches, requests for waivers and related restructurings of loans at European industrial companies with speculative-grade ratings more than doubled in number in the first ten months of 2008, compared with the whole of 2007. The companies involved came from 26 industries and three-quarters of them experienced the difficulties within three years of their previous refinancing.

At Noreco, Nagell sounded out brokers, trustees and key bondholders before going public with its buyback offer. “We knew what was good for the company and found out the main issue for investors: cash,” he recalls. The original loan agreement called for an early redemption premium of 103%, but investors’ hankering for cash allowed the company to redeem at par. And, as it has been doing for the past 12 months, Noreco will in future rely more on reserve-based lending and facilities secured against tax incentives for exploration, the CFO says. Though the administrative burden for these types of loans is higher than for traditional unsecured borrowing, the interest cost is lower and the banks involved “don’t panic when oil prices go up and down,” Nagell explains. By contrast, bond investors are “the first to disappear when markets are volatile and the last to return when conditions improve.”

This is putting many corporate borrowers in a tight spot, according a Moody’s analysis of 370 non-financial, non-utility issuers in EMEA. If these firms relied solely on available bank facilities and cash balances, one in five would not have sufficient liquidity to cover the next 12 months’ debt payments, the rating agency reports. As lenders clamp down on credit standards, this does not bode well for firms that are dependent on external financing to support their growth.

Up in the Air

Such news leaves executives in no doubt about their balance sheet options. Marcus Schenk, CFO of German utility E.ON, summed up the prevailing mood during a November conference call. “Now isn’t the time to increase our debt,” he said simply. Indeed, the value of European corporate bond issues is on track for a second consecutive annual decline in 2008. (See “Beleaguered Borrowers” at the end of this article.)

At the recent AGM for French drinks group Pernod Ricard, chairman Patrick Ricard noted that the company “grasped a magic window of opportunity” when it closed a deal to take over Swedish rival Vin & Sprit (V&S). The €12 billion loan backing the purchase — Europe’s largest-ever non-investment grade corporate loan — closed around €500m short of its target in the summer, despite a “flex” in May that boosted margins and fees in order to sweeten the deal. Now, “we could not finance a deal ourselves,” Ricard added. “We were lucky.”

Another executive breathing a sigh of relief following a fortuitous takeover is Xavier Rossinyol. After tough negotiations, the CFO of Dufry, a Swiss travel retailer, closed a deal in October to purchase Hudson Group, an American airport newsagent.

Financing the takeover is a SFr1.25 billion (€808m) loan with an initial margin of 225bp over Libor, more than double what Dufry received two years before for a loan financing a purchase in South America. Back then, “it was a borrower’s market and you were able to choose from whom you wanted the money,” Rossinyol says. As the rise in the firm’s cost of borrowing attests, this is no longer the case.

Longstanding relationships with a core group of banks and a history of deleveraging were critical to getting the Hudson deal off the ground, the CFO says. The company was able to negotiate “conditions that reflect the market in August, which are better than those in October though, obviously, much different from the ones we had two years ago.”

Through to November, Dufry’s share price was down more than 75% for the year. “It is not the most preferred type of stock today,” says Rossinyol. “We are involved in travel, retail and are a mid-cap without a lot of liquidity.” Nonetheless, the CFO is confident that the company’s strategy is sound and, with time, “if we keep delivering like we have in the past, things should return to normal.”

Until then, he will keep a close eye on cash flow and maintain frequent contact with his bankers. As for further deals, Rossinyol does not foresee much action any time soon. “Like everyone else, we need to see what’s in store for the coming months,” he says.

Indeed, for most companies deals of any description are likely to remain on ice for some time to come. A thaw is difficult to forecast, given the unprecedented severity of the freeze in credit markets. In a November survey of 115 finance chiefs by CFO, a sister magazine of CFO Europe, more than 70% of respondents expected banks to under-allocate the funds raised through government injections towards commercial lending.

“A year ago, everyone knew how the system worked,” Rossinyol says. “Now everything changes from one week to the next. There are no rules. There is a lot of mistrust in the markets.”

Much can change in a year. In December 2007, CFO Europe’s M&A round-up collected tales from CFOs who thought that the credit crunch would unlock fresh opportunities for cash-rich companies to pick up bargains.

The reality today is that the crisis has left dealmakers in a state of limbo. Having cut dividends, cancelled buybacks and convened working-capital taskforces, companies would rather hoard cash than commit to M&A. (See “Going It Alone” at the end of this article.) At the same time, executives who want to sell see little point in doing so while values are so low. And private equity firms, which fuelled the previous M&A boom, can’t access enough debt to take advantage of low valuations. “There is frustrated demand from all sides,” says Daniel Domberger at London-based corporate advisory firm Livingstone Partners.

Anglo-Australian mining giant BHP Billiton’s failed bid for rival Rio Tinto is a sign of the times. After more than a year of wrangling, BHP finally dropped the pursuit in late November 2008, making it the largest withdrawn deal in history. When launched, in November 2007, the all-share bid was worth around $140 billion (€111 billion).

In pulling out of the deal, BHP cited falling commodity prices, the post-deal debt burden and antitrust issues, a combination that produced “unacceptable levels” of risk to shareholder value. Despite writing off $450m in costs related to the bid, the suitor’s shares surged on the news. And though the banks that were to support the bid will lose out on a reported $140m in fees, the upside is that they are now off the hook for the $55 billion debt facility lined up to finance the deal.

That isn’t to say that M&A dried up altogether in 2008. Belgian beer maker InBev’s $52 billion takeover of American rival Anheuser-Busch, completed in November, was a notable mega-deal. And some companies are still on the prowl. Also in November, Eldar Sætre, CFO of Norwegian oil and gas group StatoilHydro, told analysts that the company continued to stalk targets, which “could even be cheaper than they were some time ago.”

But in contrast to the heady days of 2007, optimism such as Sætre’s will be the exception rather than the rule in 2009. “People are worried that they are going to be the sucker that buys when the market has further to fall,” says Philip Richards, a partner at law firm Freshfields. “I don’t think public company boards will have the nerve to do anything of size, even if they’ve got the resources to do it.”